While life insurance can be part of an overall estate plan, it should never be viewed as an alternative. I have spoken with a number of people who say they do not need an estate plan, they have life insurance instead. This notion is fundamentally incorrect for the following four reasons.
The Cost of Life Insurance
First, life insurance is expensive. However, my estate plan is much cheaper than life insurance. Life insurance agents will likely try to explain that you are building up equity in the policy and you can cash it out like any other investment. However, each year you are still paying mortality costs, i.e. the cost of a one-year term life policy on your life. Those costs add up and as you get older, those costs become ever more expensive. In fact, they become so expensive that by the time people are in their eighties, some are half the value of the death benefit.
For this reason, most people cash out their life insurance policies after a certain point. However, at that point the person is back to square one with no estate plan. With this, it makes more sense to get an actual estate plan now rather than later.
Tax Planning and Savings
Second, tax planning is far more difficult with a life insurance policy. In fact, if you are really interested in tax planning, but still want a life insurance policy (for actual insurance purposes) you can merge the two and create an irrevocable life insurance trust for the policy. This can result in large tax savings, especially if your estate is of high value.
Assets Outside the Life Insurance Policy
Third, a life insurance policy will not deal with any other assets you have. It is very conceivable that you may leave money outside of the life insurance policy for you to use and spend throughout your life. In fact, it is most likely that you will. In that case, if that amount is still over $25,000, your estate will still have to be probated.
Incomplete Estate Plan
Fourth, life insurance is not a complete estate plan. A complete estate plan will not only include a trust (likely a revocable living trust), but also a will, a healthcare proxy, and a financial power of attorney. A life insurance policy will include none of those.
If you are worried about leaving your family behind without enough money, you may want life insurance. This article is in no way trying to dissuade someone who is interested in life insurance from getting it. However, life insurance is an insurance policy designed to insure your life if you die in an unforeseen way, it is not an estate plan.
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